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What danger do ETFs pose for investors, and how does investing in Exchange Traded Funds compare to owning physical gold?

January 6, 2014
Video Transcript

The more pressure you put on a spring, the more you push it down, eventually the greater the explosion that's going to come out the other end. We're seeing it, of course, in the Exchange Traded Funds. Here you have a situation where people think they're backed by physical gold and even the funds that say they're backed by physical gold, are in fact, not. The reason is, is because people are allowed to short shares. Let me give you an example, let's go out and let's say just use round numbers, keep it simple. Gold is $1,000 an ounce. You form a brand new ETF. You sell 10 shares, each share for $1000, and you go out and you buy 10 ounces of gold. So now you have 10 shares and it's backed by 10 ounces of gold and it's 1,000 for 1,000, you're perfectly projected now. Now somebody comes along who thinks gold is going down, a Hedge fund. Now what they do now, they borrow 5 of those shares from people who own them and they sell them into the market place. They just borrow them and sell them. Then 5 new buyers buy those shares, so now you have 15 people who own shares in your ETF, 15 people think there's an ounce of gold behind their shares. In reality, there's only 10 ounces of gold.

So, you have 15 people who think they have gold and only 10 do. When push comes to shove, then you're going to find out you're at the end of the list. There's no gold for you. That could be solved with legislation, if they require-- that if you want to short a share, then you have to put an ounce of gold in. Until that happens, that's never going to happen, then the ETFs aren't the protection that you thought they were. There's nothing like having it physically in your hand, where you can take it with you. Other than that, the rest is just paper promises. There's 100 times more paper gold out there than there is physical gold. So there are a lot of people who think they're protected, frankly, they're just not. Unfortunately, I feel very sorry for them, because they're trying to do the right thing, but they're just doing it in the wrong way. They took action, but they took the wrong action.

Holding gold in the futures market, right now the Comex is the first to tell you, that if everybody who had a future's contract showed up and said, "Give me my gold," only the first 2% get gold the other 98% get cash. Well, the whole reason you bought gold is so you won't have cash. So while it's physically available, that's the real market. That's the market I want to participate in. That's where the real insurance is.

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